Thursday, May 13, 2010

California Dreamin'

Many investors have been asking me about their California Municipal Bonds, before I go any further please note this post does not represent any type of investment advice.

So what should you do with your Cal Muni's. California is in the tank, another $20 billion budget deficit and no possible way to fill it without major tax increases (which failed to work last time) or significant cuts to what many consider vital services. So what should California do? The likely answer is one that might sound counterintuitive. They should spend more and become hopelessly deadlocked in the budget battle. Why? One word - Greece.

The Obama administration and the Federal Reserve played a big part in helping the EU/IMF bailout Greece and set up a fund to bailout other bankrupt EU nations - in fact the US will pitch in more than $50 billion. If Obama and the Fed think Greece is systemic, I'm willing to bet they aren't going to let California (the worlds 8th largest economy) fail. Everybody knows this; we have institutionalized Too Big Too Fail and California is the poster child for profligate spending and bad behavior....i.e., they make the perfect bailout candidate. Of course the government will be loath to bailout just California (as the EU was loath to bailout just Greece) when New York and many other states have issues as well - so look for another stimulus/state bailout bill. This will be another short-term cure that will transfer more debt onto the Fed's balance sheet, but who cares, whats another few billion or trillion dollars?

Will some California muni bonds default, possibly, but I'm willing to bet that like Greece, they will all be made whole in the short term. My main concern however is the duration, I'd keep my duration short (though longs are paying nice returns right now).

Can I be positive of a bailout - no. Is it likely given the current circumstances - yes. Be mindful though that this bailout will cause irreparable harm to the country.

Scott Dauenhauer CFP, MSFP, AIF